Looking forward to a mis-sold PPI windfall? So is the taxman

Payment Protection Insurance (PPI) has been keeping Martin Lewis in cashmere socks for years. Spotty bank clerks foisted these insurance policies on practically all customers, whether they wanted them or not, or even whether they were eligible to claim under said policies for years. And years. However, customers eventually got wind of this big moneyspinning wheeze for the banks, and a number of high profile court cases followed, culminating in a crucial High Court defeat in April. British banks lost the appeal over new rules which require insurers to review past sales of PPI, even when customers had not complained.

As a result, many customers are now receiving payouts, or are expecting some kind of cash back after banks were forced to set aside more than £7 billion in compensation. It is estimated that there are about 12 million outstanding policies.

Those mis-sold PPI can claim back the cash value of up to six years’ premium payments made, plus a charge of 8% interest on that cash to compensate for the period where the bank had customers' money. The average payout is expected to be £1,000, which will include around £240 in interest.

However, those expecting an entirely tax-free windfall are in for a shock. While the refunded payments element of compensation will be ignored by the taxman, he is very interested in the notional interest element of the compensation. Treating this as if it were ordinary bank interest, this amount should therefore be taxed at either 20% or 40% depending on whether you are a basic or higher rate taxpayer. This gives an ‘average’ tax charge of £48 or £96.

A spokesman from HMRC told the Telegraph: "No tax is generally due on the repayment element of compensation paid to those mis-sold PPI. However, the additional interest is taxable – in line with other compensation claims. Nobody should be worse off, as had the customer not purchased PPI, but kept that money in an interest-bearing account, the interest received would have been taxable. Customers should check with their PPI provider as to whether tax has been deducted at source."

So, according to the taxman, the tax treatment of bank interest received is being applied correctly, but is it right?

Last night consumer groups called for banks to foot the bill. Marc Gander, of the Consumer Action Group, said “For years [the banks] took people’s money … and lent it back out through overdrafts, personal loans and credit card loans charging interest rates of between 15 and 29 per cent. When they are finally rumbled and ordered to pay it back they are charged just 8 per cent in interest, a fraction of what they have made from their customers in the meantime.”

Similarly, we can only assume that HMRC is not going to repay the tax charged on the profits earned by the banks on this extra income, so by levying a double-tax charge on the individuals as well, surely the taxman is having his proverbial cake and munching it too? 20% of an average £240 per £1,000 out of £7 billion is a nice little earner for the Treasury. Bet someone will be getting a bonus...